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The Actuary The magazine of the Institute & Faculty of Actuaries

How reviewable are your policies?

In mid-2003 a working party was formed to examine the technical and practical aspects of reviewing non-profit life insurance contracts. In particular we wanted to look at those contracts where the product provider has discretion to amend some aspects of the contract. This merry band of workers included representatives from a range of life offices, along with some lawyers to provide a legal perspective.

A history of reviewability
For many years, life insurance products were limited to traditional with-profits endowments, whole-of-life and pensions contracts, and non-profit guaranteed protection products and annuities. However, during the last 30 years, increased computer power, new types of benefit, and soaring stockmarkets have resulted in some radical product developments. A selection of those relevant to this discussion are shown in table 1 below.
The result of all this innovation is an increasing portfolio of various reviewable policies, and a requirement to perform reviews.

How does it work in practice?
The details of the reviewability of a policy have to be described in the terms and conditions (T&Cs) set out in the policy document. Typically the T&Cs specify a method of review, but in many cases they retain specific flexibility for the appointed actuary or the directors to set some assumptions or parameters.
Before July 1995, terms describing the discretion to conduct reviews could be very general and wide-ranging. For instance, some T&Cs included a phrase similar or identical to ‘charges can be varied at any time ’. On 1 July 1995 the Unfair Terms in Consumer Contracts Regulations (the Regulations) came into force, requiring greater specificity in such contract terms, particularly where there is discretion to change the price or other terms of a contract. The Regulations provide that a term in a consumer contract (such as an insurance policy) is unfair if it causes a significant imbalance in the rights of the parties to the detriment of the consumer. Contract terms which give one party the right to vary the terms of the contract unilaterally, particularly its price, are considered to create such an imbalance.
To ensure insurance policies do not violate the Regulations, they must be drafted in a way whereby consumers can be sure of getting what they were promised under a given policy. It is therefore necessary for contracts to be explicit about the circumstances in which discretion can be exercised by the company, and more recent contracts tend to include much greater detail of how this discretion might work. The effect of the Regulations was to create greater transparency in the conduct of policy reviews.
The general mechanics of reviewability are understood fairly widely in the actuarial profession, but the specifics will vary from company to company, not least because of different T&Cs. Interpretation of the T&Cs many years after they were first written can be challenging, and may give rise to a number of different interpretations. Let us consider some of the questions that might arise:
– Expense charges The typical practice is to review expenses upwards annually, often in line with the Retail Price Index (RPI) or similar. Some T&Cs specify this method. In other cases it represents a pragmatic approach to more general T&Cs. But how does this change relate to the actual change in expenses? Does a company have an obligation to use actual experience? What would the company do if for some reason, eg outsourcing, expenses suddenly reduced significantly? What if new regulations led to much higher expenses? How does a company ensure consistency of approach to these questions from one appointed actuary or board to the next?
– Risk benefit charges Many companies monitor actual mortality and morbidity experience. However, it is often unclear to what extent, if any, the results of an experience investigation need to be reflected in a review of charges or premiums. Should any allowance be made for a trend? For instance, if a certain factor is increasing according to recent experience, do you allow for the expected increase to the next review date? How should a company interpret experience at ages where data are particularly sparse? In some cases reassurance terms can be as important as actual experience, but are changes in reassurance rates sufficient reason to change the underlying charges? Are reassurance premium changes purely reflective of changes in mortality or morbidity experience, or do other factors affect premiums? What information, if any, should be given to policyholders to justify changing (or retaining) existing charges?
– Investment return In respect of certain review types (such as endowment mortgage policies) a company will regularly review its investment growth assumption in the light of experience, market expectations, and the need to have regard to the regulator’s projected growth rate bands. How do you ensure consistency of approach in setting this most subjective of assumptions, when a contract can have a term of 25 years and the investment climate can vary as much as it has over the past 25 years? To what extent, if any, should market consistency concepts be reflected in the assumptions?
These ideas represent just a selection of the possible issues. Table 2 contains a more complete list showing the variety of areas of discretion that can exist in a non-profit contract. How much of this do we expect policyholders to understand and appreciate?

The current environment
There are many reasons for performing this study now:
– Currently, there is a lot of related activity, as increasing numbers of policies come up to review.
– There are ongoing concerns about mortgage endowment reviews.
– Recent critical illness reinsurance concerns and continuing improvements in mortality raise questions about what experience can or should be passed on to policyholders.
– At the same time, the Financial Ombudsman Service has been scrutinising rate reviews for critical illness policies.
– In recent years the industry has introduced the ‘Raising Standards’ initiative, with a view to increasing transparency. How transparent is the review process?
– We have just had an FSA review of the biggest area of actuarial discretion: with-profits business.
Although the FSA’s review and resulting consultation and rules has not explicitly considered discretion in relation to non-profit business, it is worth noting that the FSA’s guidance in respect of with-profits business is often referred to as the application of PRIN6 the requirement to treat customers fairly. This same principle also applies to non-profit business. Furthermore, actuarial guidance in Guidance Note (GN)1 clearly requires the appointed actuary to provide his or her interpretations of policyholders’ reasonable expectations (PRE) and ‘treating customers fairly’ in relation to all areas of discretion, and not just in relation to with-profits business. Hence, it is likely to be instructive to analyse the results of the FSA’s review of with-profits business and to consider the potential implications for non-profit business. In particular, it seems reasonable to conclude that any lack of transparency surrounding the exercise of discretion may give rise to unfairness for non-profit policyholders. As a result, companies providing non-profit policies may need to provide greater disclosure of these matters in the future.
A further complication arises from the expected changes to the responsibilities of actuaries in life companies. It is likely that any discretion allocated by T&Cs to appointed actuaries will need to be reviewed, and potentially amended, to reflect the board’s overriding responsibility for company management.

What are we doing?
We started by collecting sample policy T&Cs and subjecting them to legal analysis by the lawyers in our group. They examined the relevant legislation and the legal precedent and guidance that might apply, and communicated these to the rest of the working party. We then considered the wide range of circumstances in which reviews might take place and the issues arising.
Having considered the theory, we would now like to understand the practicalities, and so we have prepared a survey to ascertain the size of the portfolio of reviewable policies and the mix of reviewable business in the market. We are also surveying the approaches taken by different companies to the reviewing of policies. The survey will be distributed to appointed actuaries soon. We intend to summarise the results of the survey and comment more fully on current practice in the light of recent developments, and provide details to the actuarial profession later this year.